A Primer on Value Investing
Seth Klarman through his Baupost Fund is
one of the greatest investors of the current generation, perhaps of all-time.
This 1991 book is an investing classic, so much so that it sells for $780 on
the secondary market. The key insight for most value investors is the all
investments must have an inherent margin of safety. That means looking at the
downside before looking at the upside. The notion of risk is asymmetric, not
the standard deviation of returns as modern portfolio theory suggests. For
example for any given stock under modern portfolio risk is independent of
price; for a value investor risk is extraordinarily dependent upon price.
Klarman is focused on absolute performance,
not relative performance. Thus unlike the bubbleheads on CNBC he doesn’t have
to be invested all of the time. He is rightly skeptical of Wall Street research
and the exotic products their investment bankers come up with.
The key earnings metric for Klarman is
rightly free cash flow. It is not earnings per share and it is not EBITDA.
Depreciation is real and so too are capital expenditures which do not enter the
income statement.
The reader has to remember that this
book was written in 1991 against the backdrop of the 1987 crash, the junk bond
collapse and the 1990 bear market. He is critical of newly issued junk bonds
(high yield in today’s terminology). Little did he realize that 27 years later
high yield would dominate the new issues. He is also critical of the index
funds that now dominate today’s stock market. For the average investor index
funds make a great deal of sense.
Why? Simply put the average investor
doesn’t have the talent or the time to be a value investor like Klarman. To be
another Seth Klarman takes more than a few brains and much hard work.
“Margin of Safety” is written in clear
and concise language. My two criticisms are that there are far too few examples
of value investing in action and it is obviously dated. Nevertheless the
lessons to be learned from reading the book are timeless.
The full Amazon URL appears at: https://www.amazon.com/review/RLBRF216819WU/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv
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